All kinds of things divide Americans and Europeans -- an ocean, languages, diet, and work habits, to name just a few. You can add another item to the list: The different values they put on stocks, especially technology-related stocks. Despite the recent surge in the euro against the dollar, U.S. tech stocks typically have valuations 20%-25% higher than European peers. That could spell opportunity for investors who take the trouble to look across the Atlantic for technology buys.
The valuation gaps can be striking. For starters, consider Ericsson
Shares of IT outsourcing specialist, Electronic Data Systems
A glimpse at the semiconductor business shows the same kind of story. German commodity chip producer Infineon Technologies
It doesn't end there. Take British Sky Broadcasting
Mind the gap
So, what explains the gaps? It all boils down to the different ways that European and American investors look at the value of companies.
When it comes to valuing technology-related companies, the basic approach is to build a 10-year forecast, accounting for cash in and cash burn, in what analysts call a discounted cash flow (DCF) analysis. The thing is, forecasting likely revenue in just a couple years time -- never mind 10 years time -- is at best guesswork. Face it, a difference in a license fee of 10%-15% on sales worth $1 billon, or even slight variations on growth and risk assumptions, can translate into a big difference in valuation. As a result, stock prices are driven by investor sentiment and individual views as to the kind of revenues and cash flows the companies will deliver.
U.S. investors, as it turns out, have a bigger appetite for risk. When it comes to valuing a company that has, for instance, made some blunders in the past or, say, carries more debt than might normally be thought advisable, American investors are more willing to forgive and forget than are Europeans. So, their valuations tend to be higher.
You might think that the valuation gap would narrow when you turn from fancy DCF models, to "normal" metrics like P/E and cash flow multiples. Nope. Americans tend to pin higher hopes on the earnings potential of technology companies. The effect is that U.S.-based companies, exposed to more American investors, trade at a premium.
The lesson is pretty clear. If you plan on buying technology stocks, it might just pay to check out Europe. Thanks to Europe's less forgiving and more skeptical investors, stocks there can be much cheaper than those trading stateside.
Caveat emptor
That said, don't get caught in a value trap. Sure, some European stocks look cheap. If it's because the market has yet to spot their true value, great, that probably means the firm represents a buying opportunity. Other times, however, there is nothing to say the valuation gap is wide, because those U.S. stocks are way overvalued.
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Fool contributor Ben McClure hails from the Great White North. Ben owns shares in British Sky Broadcasting, but none of the other companies mentioned here. The Motley Fool is investors writing for investors.
